- The Foreign Trade Policy corrects both excess demand and deficient demand
- Balance of Trade = Exports − Imports
- Export Surplus = Exports > Imports = Favourable BOT
- Import Surplus = Imports > Exports = Unfavourable BOT
- Exports fix deficient demand — they work just like investment in boosting aggregate demand
- Three factors that raise exports: foreign income ↑, export prices ↓, surplus production ↑
- Imports fix excess demand — more goods in market → prices fall → inflation controlled
- Import surplus is financed by: foreign reserves, IMF/World Bank loans, foreign grants
Definitions [2]
Definitions: Fiscal Policy
- "Fiscal Policy is the policy concerning the revenue, expenditure and debt of the government for achieving definite objectives." -Prof. Dalton
- "Fiscal policy involves alterations in government expenditures for goods and services or the level of tax rates. Unlike monetary policy, these measures involve direct government entrance into the market for goods and services (in case of expenditure) and a direct impact on private demand (in the case of taxes)." – Prof. Gardner Ackley
- "We define fiscal policy to include any design to change the price level, composition or timing of government expenditure or to vary the burden, structure or frequency of tax payment." – G.K. Shaw
- Fiscal policy includes those "Changes in government expenditure and taxation designed to influence the pattern and level of activity." – Harvey and Johnson
- Fiscal Policy includes those "Changes in taxes and expenditure which aim at short run goals of full employment, price level and stability." – Otto Eckstein
Definitions: Monetary Policy
“The management of the expansion and contraction of the volume of money in circulation for the explicit purpose of attaining a specific objective such as full employment.” — R.P. Kent
“Monetary Policy consists of the steps taken or efforts made to reduce to a minimum the disadvantages that flow from the existence and operation of the monetary resources in the economy to attain certain specific objectives….” — Prof. Crowther
“Monetary policy involves the influence on the level and composition of aggregate demand by the manipulation of interest rates and the availability of credit.” — D.C. Aston
“By monetary policy, we mean any conscious action undertaken by the monetary authorities to change the quantity, availability and cost of money.” — G.K. Show
Key Points
Key Points: Structure of Public Finance > Fiscal Policy
- Fiscal policy = government's decisions on spending + taxes + borrowing
- Instruments: (i) Public Expenditure, (ii) Taxation (Direct & Indirect), (iii) Public Debt & Deficit Financing
- Taxes reduce disposable income → reduce consumption → reduce AD
- Government spending directly raises aggregate demand
- Multiplier =\[\frac{1}{1-c}\]: a rise in G leads to a proportionally larger rise in Y
- Excess demand → Contractionary fiscal policy (↑ tax, ↓ spend, ↑ borrow)
- Deficient demand → Expansionary fiscal policy (↓ tax, ↑ spend, deficit finance)
- Keynes gave fiscal policy its modern importance after the Great Depression (1930)
Key Points: Fiscal Policy and Deflationary Gap
- Reduce taxes to increase disposable income of households and spending by firms, which raises aggregate demand.
- Increase public expenditure on public works, welfare, health, education, and subsidies to boost demand and employment.
- Increase deficit financing to inject more purchasing power into the economy during deficient demand.
- Reduce public borrowing so that people retain more money for consumption and investment.
Key Points: Fiscal Policy and Inflationary Gap
- Increase taxes to reduce people’s disposable income and purchasing power, thereby lowering aggregate demand.
- Reduce public expenditure on public works, subsidies, and non-essential spending to control excess demand.
- Reduce deficit financing to prevent further increase in money supply and inflation.
- Increase public borrowing to absorb excess purchasing power from the economy.
Key Points: Instruments of Monetary Policy
- Quantitative tools control the total amount of credit — they affect everyone equally.
- Qualitative tools control the direction of credit — they target specific sectors or borrowers.
- The four main quantitative tools are: Bank Rate, OMO, CRR, and SLR.
- Margin requirements are especially effective in curbing speculation and hoarding in commodities markets.
- Moral suasion relies on persuasion, not force — it is the softest tool available to the RBI.
- Cheap money policy fights deflation by making borrowing easy.
- Dear money policy fights inflation by making borrowing expensive.
Key Points: Objectives of Monetary Policy
- Exchange stability: To maintain stable exchange rates and ensure balance in foreign trade and balance of payments.
- Price stability: To control inflation and deflation so that prices remain stable and public confidence is maintained.
- Full employment: To reduce unemployment by regulating credit and encouraging investment and economic activity.
Key Points: Foreign Trade Policy
